Traditional Businesses, Not the Next Dot.com, Will Lead to Office Recovery

At the recent Building Owners and Managers Association Annual meeting in Chicago, Marc Itnermaggio, Director of San Francisco’s BOMA chapter, concluded that there is too much uncertainty in the economy to determine what next wave will lead to job growth and therefore reduction in office vacancy.

At a recent TCN Worldwide northeast regional meeting in Pittsburgh, affiliates from Detroit, Pittsburgh, Buffalo and Cincinnati were hoping that new ball park stadiums and casinos would lead to needed office and retail recovery. At a TCN Worldwide eastern region meeting in New York, affiliates from Philadelphia, Boston and New York were talking about biotech leading to an office recovery.

Optimism is great, the reality is that history tells us what will lead us to recovery and that is traditional businesses that will take advantage of lower office rents to grab more space than they need now to handle their growth needs in the future.

During the last major downturn that started in 1985 and hit its worst in 1991, that cycle was dealing with over capacity of office space that was created to meet a false economic demand. Through tax advantages and lenient financing offered by the government and the savings and loans, spec office development was actually used to create jobs that in turn would need more office space. It worked until capacity far exceeded demand and development stopped, which in turn slowed job growth that created the downward cycle which eventually lead to its crash.

This latest doom and bust cycle, which started in 1998, was also started by a new industry expansion (dot.com), which was based upon unrealistic growth demands that would fuel the expansion of office development. The good news is that this cycle was not long enough to see too much development that would have led to an over capacity of new spec office space. This cycle helped lower vacancies in existing buildings that were built for the most part in the 1985-1991 cycle. This is an important distinction because we have not added significant amounts of new office space that would have to be absorbed on top of the earlier cycle’s remaining vacancy.

Casinos, ball park developments and bio-tech may create some limited demand for office space but the reality is that none of these current “dream” markets offer the country, as a whole, an economic vehicle to recover. What it does is make you look back to our traditional base businesses.

Rents in most markets are down to 1991 levels. In downtown San Francisco, Class A space has dropped from an average of $62.00, in the height of the dot.com, to currently $32.00. At these levels traditional businesses will recognize that they have been given a “shot in the arm” to grow. Rents to an average business fall first through third as the single highest expense that they have. If rents are 50 percent of what they were projected to pay, the business has gained cash savings that they can use to improve the efficiency of their current operations and therefore expand productivity. Higher productivity will lead to the creation of additional jobs, which in turn will lead to the need for more office space. Once a need for new office space occurs, a new cycle will begin that will lower the current high office vacancies

I am not losing sight of the fact that building owners will suffer through this process. These rents will not create profitability for them and some may lose their buildings as a result. But to dream that the FDA will shrink their approval timeline for new drugs that will create a boom in biotech, or to believe that building a casino or ball park will fuel office development as a result is “putting their heads in the sand”.

Building owners should be promoting these current low rents and create a strategy that would allow businesses to absorb these high office space vacancies with incentives to take more space than they need now so that businesses will be ready to grow when the new cycle begins to appear. One strategy is using more office space to create a job benefit to existing employees. Most businesses are not in a position to offer raises in these times but can motivate office workers by offering them a better office environment. In this last cycle rents have skyrocketed and businesses were forced to squeeze more employees into a smaller work area. With today’s rents, businesses can spread their operations out, allowing more for space per employee.

Organizations like BOMA can lead this charge. It is a lot better strategy than “twiddling their thumbs” waiting for something to happen.